The Effect Of Risk

With credit to http://www.marketwatch.com/story/the-first-shall-be-last-2012-01-03

A portfolio that bought the strategy that was the most successful in the previous year produced a 23% annualized loss. A portfolio that bought the strategy that was the least successful in the previous year produced a greater than 50% annualized loss.

The explanation is risk. To end up as the best or the worst performer of a sample, the strategy is likely to have taken excessive risk, which resulted in an extraordinarily large profit or loss. The odds are that excessively risky strategies will eventually lose big.

Lessons here:

  • Investing by looking in the rear view mirror is likely to fall victim to mean reversion.
  • Producing a winning strategy is not simply a case of reversing a losing strategy.
  • Controlling risk is the route to not blowing up.

 

Leave a comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: